Pensions Find New Life as Tax Strategy for Service Professionals

Pensions are being marketed as a way for service professionals to get around the new tax rules.

Pensions, also known as defined-benefit plans, can be used by doctors, law partners and wealth managers to stash hundreds of thousands of dollars in income a year. By doing so, they’ll get around the income limits Congress created to bar them from a generous new tax break for owners of pass-through entities, who report the firms’ income on their individual tax returns.

The Treasury Department proposed regulations last week specifying who qualifies for the 20 percent deduction, which effectively slashes the top tax rate to just under 30 percent from 37 percent. The rules also say that planning techniques such as the “crack and pack” — where business owners split their firms into different entities to lower their tax bills — are considered abusive.

Defined Benefit Plans for Service Professionals

With a cash balance plan, participants know each year how much they individually hold. Employers make contributions according to a set formula and manage all participants’ investments collectively, usually guaranteeing a set return.

The contribution limits are based on age: Generally, workers in their 30s and early 40s can pitch in less than $100,000, but limits for older workers rise quickly, to above $200,000 for those in their late 50s and above $300,000 for those in their late 60s.

Many large law firms and medical groups already offer cash balance plans to help their highly paid partners lower their tax bills. While these professionals may boost contributions, if possible, to try to take advantage of the pass-through deduction, the biggest potential opportunity under the new law is for the thousands of smaller businesses that don’t yet have such offerings.

Defined-benefit pensions can shield more income from the IRS than a 401(k)-style defined contribution account or individual retirement account, or IRA. Annual employee contributions are capped at $18,500 this year for 401(k)s and $5,500 for IRAs for those under 50.

A cash balance pension is the “next logical step” for successful business owners who are already funding their 401(k) profit-sharing plans up to their limits and want to avoid taxes by deferring even more income.

Help in Setting up a Defined Benefit Plan for your Service Organization

If you are interested in setting up a defined benefit plan, please contact our office. We can help guide you and ensure that you are optimizing the tax advantages offered by the new tax laws.